Shane Whelan

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Particle Finance The Future of Investing

• Shane Whelan

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Growth in World GDP per Capita, 1000 -2000
Source Cornucopia Increasing Wealth in the
Twentieth Century, J. Bradford DeLong, 2000
http//econ161.berkeley.edu
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Industrial Worlds GDP per Capita, 1870 -1995
Source Economics Making Sense of the Modern
Economy, The Economist, 1999.
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Measured Labour Productivity in Private Sector
Source Economics Making Sense of the Modern
Economy, The Economist, 1999.
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Growth in the Unmeasured Economy

• Productivity slowdown in service sector.
• In service sector often we find, Unit of Output
  No. of Hours Worked.
• 10-15 move out of agriculture industry into
  services. (Services represent 70 or so of GDP in
  leading economies).
• Productivity understated ? inflation overstated.
• Fed. Reserve of Philadelphia says productivity
  understated by 2-3 since 1974.

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History Outlines a Range of Possibilities

• Developed World economies can post couple of
  decades of 3.5- 4 measured real growth.
• Standard of living increases faster than measured
  productivity (extra 1 or so p.a.).
• 5 growth ? standard of living doubles every
  14 years.
• 3½ growth ? standard of living doubles every
  20 years. 1½ growth ? standard of living
  doubles every 50 years.

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IT is it

• Moores Law computing power doubles every 18
  months while computing costs fall exponentially
  (perhaps halving every 12 months).
• Leads to proliferation new uses - 30 years ago
  just 50,000 computers in world. Since 1996 over
  half workers in US now use one.
• Constantly driving change - service sector is
  revolutionised. When over 50 penetration then
  revolution (economic historian Paul David of
  Stanford).

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The Productivity Miracle
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The Productivity Miracle
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The Productivity Miracle
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Measured Labour Productivity in Private Sector
Source Economics Making Sense of the Modern
Economy, The Economist, 1999.
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Measured Labour Productivity in Private Sector
Source Economics Making Sense of the Modern
Economy, The Economist, 1999 Goldman Sachs,
The New Global Economy, 16th Feb. 2000.
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Growth in World GDP per Capita, 1000 -2000
Source Cornucopia Increasing Wealth in the
Twentieth Century, J. Bradford DeLong, 2000
http//econ161.berkeley.edu
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Risk Transfer

• It is often supposed that the costs of
  production are threefold, corresponding to the
  rewards of labour, enterprise, and accumulation
  capital. But there is a fourth cost, namely
  risk and the reward of risk-bearing is one of
  the heaviest, and perhaps the most avoidable,
  burden on production.
• J. M. Keynes, Preface to A Tract on
  Monetary Reform (1923).

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Risk Transfer Function

• Investment Risk
• Withdrawal of investment guarantees
• Savings move to unit-linked
• Pension schemes move to defined contribution
• Other Risks
• Catastrophe risk
• Finite risk reinsurance
• In general, Individualisation of Risk

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Advances in Risk Pricing

• A dyke height of 5.14m above Normal Amsterdam
  level is sufficient with probability of failure
  10-4 (once in every 10,000 years).
• de Haan, Fighting the Arch-Enemy with
  Mathematics, Statistica Neerlandica 44 (1990)

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Risk Inefficiently Distributed

• No insurance
• Markets developing to fill void
• Financial options
• Catastrophe bonds
• Catastrophe options
• Novel new contracts
• Weather-linked derivatives

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Promising Beginnings

• Recycling equity capitalUGG deal at end 1999
  replacing equity capital with contingent equity
  catEput.
• Debt plus risk transfer substitution for
  equityCanada Airlines, Alterra, Colombia power
  plant, MBO in UK.
• Competition in traditional reinsuranceGoldman
  Sachs place Tokyo Disneylands cat bond, 1999.
• Securitisation of insurance portfoliosHanover Re

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Particle Finance the building blocks of risk

• Logic of diversification
• The science to price it
• The technology to transfer it cheaply
• Asymptotically, heading towards the completion of
  the markets every contingent claim has a market
  price
• Role of actuaries in pricing, reserving,
  managing, and regulating

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Economic Growth Rate for 21st Century

• Progress is still evident
• Plenty of helpers
• 6-7 of mankind are alive now
• More time to contribute, life expectancy in 1750
  was 27 now 58
• The democratising of education
• Incentive to change
• Gap between the rich and poor continue to widen?
• 17 richest nations in 1870 had 2.4 times income
  per head as all the rest, in 1990 the same group
  had factor of 4.5 times.
• Lant Pritchett,
  Journal of Economic Perspectives, Summer 1997.

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Growth in GDP per capita, Western Europe ( p.a.)
Source The Economist, Millennium Special
Edition, with 2100 estimated.
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Conclusion

• Limited Liability was great financial innovation
  of 19th century.
• Alternative Risk Transfer (ART) -decomposing
  risk into its fundamental particles - could be
  the financial innovation of the 21st Century.

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Particle Finance The Future of Investing

• Shane Whelan